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PANIC
The stock market returns in much of American history have been so good that they’re difficult to comprehend. The 45-year period from 1970 to 2015 included a financial crisis, the bursting of a stock-market bubble, and the bursting of two real-estate bubbles; but stocks still managed to multiply an investment 97 times. That is, if you invested $100,000 in 1970, 45 years later you had $9,700,000. Half of that, $4,850,000, came to you in 2011-2015, when your nest egg doubled for the last time.
That’s strange, because most of the time the stock market is a wonderful mechanism for predicting future earnings and interest rates, which are the only two things that matter in valuing stocks. Tens of thousands of investors each bring to the market an important insight or a valuable piece of information and toss it into the pot, from which rises a forecast of the future. Toss in a handful of fear, and you get nothing but demons and goblins.
It’s not hard to get a decline started, because bad news is easy to come by, even in the best of times. Perhaps the latest economic statistics were a bit soft, or the last inflation report was higher than expected. Stocks have a bad day, a bad week, and then a bad month.
Stock-market pundits who have been calling for a decline suddenly feel vindicated, and TV programs give them air time to explain why they’ve always been right. 50,000 investors look at the still-falling indices, listen to the commentary, and sell part of their holdings; causing the market to fall further. This brings up memories of brutal market declines in past decades, and more people throw in the towel and sell. Hedge funds sell short, massively. A well-known bullish analyst changes his mind, causing his followers to sell. Technicians trumpet that the waves of selling are so powerful that support has been broken.
This is a self-sustaining dynamic, but eventually we reach the point where all the selling has been exhausted. Not all investors are willing to participate in this game. Corporate CEOs and other insiders buy shares, as do value investors who have cash available. Short sellers have to buy shares to take profits. Corporations buy their own stock, and fearless individuals make their annual IRA contributions and buy shares.
In 2016 the market bottom was established when one of our clients asked us to sell everything. Other investment advisers talk about the same phenomenon; one says that stocks never bottom until they have a “GMO”; a call from a client saying “Get Me Out”. Don’t be that guy!
Once the market starts rising, the same forces can propel it to unreasonable heights. “Reasonable” values can only be determined in hindsight, after we find out whether interest rates really did rise, or earnings really did decline. In the end, earnings and interest rates are all that matter.
The world is more connected than it’s ever been, so fearfulness is easy to measure. If YOU feel afraid, the herd is afraid. And it won’t be long before stock prices bottom.
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